Berkshire’s weird buyback

By Felix Salmon
December 12, 2012

There are a lot of very weird aspects to today’s announcement that Berkshire Hathaway has bought back $1.2 billion in stock.

Firstly, the way that the announcement came out seems incredibly shambolic. The stock market opened, and then just a few minutes later trading in Berkshire was halted, pending a news announcement. The announcement was made, and trading resumed, but there’s really no reason why the announcement couldn’t have been made ten minutes earlier, before the market opened.

Secondly, the buyback took long enough: Berkshire first announced that it was thinking of doing such things back in September 2011, saying that it would buy back stock “at prices no higher than a 10% premium over the then-current book value of the shares”. After that there was nothing, until today — when Berkshire, with its very first first significant buyback, managed to break its own self-imposed constraint:

Berkshire Hathaway has purchased 9,200 of its Class A shares at $131,000 per share from the estate of a long-time shareholder. The Board of Directors authorized this purchase coincident with raising the price limit for repurchases to 120% of book value. Berkshire may purchase additional shares in the market or through direct offerings at no more than 120% of book value.

This smells. “The estate of a long-time shareholder” is clearly code for “an old friend of Warren’s”. When that person died, the estate clearly took the decision to liquidate the entire holding, possibly for fiscal-cliff-related reasons. (There’s a good chance that the taxes on estates and capital gains will rise substantially in 2013.) It’s possible that Berkshire was a little bit worried about the effect that the sale would have on the share price, but it’s unlikely: average volume in the stock is more than 56,000 shares per day, so selling 9,200 shares without moving the market much is pretty easy.

So there’s no particularly good reason why Berkshire should step in and make this purchase just to keep the market price smooth, especially when Buffett says he doesn’t pay much attention to short-term stock-price fluctuations anyway. And there’s definitely no good reason why this particular estate sale should be the catalyst for the Berkshire board breaking its own rules, and buying back its stock at levels far in excess of 110% of book value. (Book value is $111,718 per share, which means that the buyback price was just over 117% of book value.)

Finally, there’s no good reason why the buyback should have been done in this highly undemocratic manner. As we have seen, some $7.5 billion in Berkshire A shares change hands every day: Berkshire Hathaway, as a public company, made the decision many years ago that the stock market was the best place for its shares to trade. And yet, when it came to its first-ever stock buyback, Berkshire decided that it didn’t want to go to the stock market after all, and instead just did a bilateral side deal with the estate of a long-time shareholder.

Buybacks are considered a good thing, on the stock market, for three reasons. Firstly, they reduce the number of shares outstanding, which means that the value of the remaining shares goes up: the company is worth the same amount, so the value per share is higher. Secondly, they provide an extra bid in the market, which helps support and drive up the share price. And thirdly, they give shareholders the opportunity to sell their shares back to the company: if they want to sell where the company is buying, they have that option. And options are worth money.

Berkshire, with this buyback, achieved the first of those three reasons, but punted on the other two. It didn’t provide a bid in the market, and it didn’t give its shareholders that lovely marginal option of selling their shares to the company rather than to the traders who are in and out of the market every day. Instead, it decided to give special treatment to a single long-term shareholder.

The whole point of the stock market is that shares are fungible, and that all shareholders are equal. Berkshire has violated that principle today, for no good reason — while also breaking its self-imposed discipline of only buying back shares if the price is below 110% of book value. If you’re going to do a buyback, this is pretty much the worst way to do it.

Update: Apparently I shouldn’t trust Yahoo Finance, and when it reports volumes in BRK-A, it’s actually overstating them by a factor of 100. i.e., when it says 90,800 shares were traded yesterday, in fact that means that 908 shares were traded yesterday. Sorry.

Update 2: Ben Berkowitz correctly points out that this is Berkshire’s second buyback. It previously bought back $67.5 million of its shares from September 2011-December 2011 and disclosed the repurchase in its 10-K.

13 comments

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Help me understand why BH would pay *any* premium when the could just buy 9200 shares at the market price to achieve the same effect?

Posted by Doubleday | Report as abusive

It looks like that’s what they did, DD – yesterday’s closing price $130,831. It’s higher this am. Much ado ….

Posted by MrRFox | Report as abusive

Doubleday, that’s what I was wondering, but I think they are talking about a premium over their book value, not their market price.

Posted by KenG_CA | Report as abusive

What KenG_CA said. The market price for Berkshire shares is more than the book value of Berkshire’s assets. (That’s normal for most healthy companies. In fact, Berkshire has a relatively low multiple, though I’d guess that most companies they’ve bought had higher multiples before assets got evaluated for Fair Market Value, and assigned some Goodwill, during the process of being merged into the Berkshire empire.)

Posted by Auros | Report as abusive

I don’t understand the first reason. If you buy some shares at market value, the share value of the remaining ones should remain pretty much unchanged… I guess I’m missing something.

Posted by Bernardo_CM | Report as abusive

“the company is worth the same amount”

It is not worth the same amount, it has a smaller amount of cash on hand (or higher debt) in whatever amount it paid for the stock.

Posted by QCIC | Report as abusive

BTW, the unreliability of that free data you were using about trading volumes kinda illustrates the point I and other commenters were making on your post about Bloomberg and LinkedIn.

Posted by Auros | Report as abusive

QCIC is right – cash goes out the door. Company is worth less, but fewer shares outstanding. And actually (this is the whole Berkshire thing), Book Value Per Share DECREASES when you repurchase at prices above Book Value. $2B company, 100 shares = $20M BV/share. Buy back shares at 120% Book, or $24, and you now have $1.976B and 99 shares = $19.96M BV/share.

So very interestingly Berkshire’s buybacks limit themselves – book value per share falls as long as they buy at over 100%.

The article is right that it is just weird. Apparently they couldn’t announce first as the price would shoot up, but they obviously got the deal pen-ready, approved 120%, signed the deal, and then announced the new rules. Maybe THAT’s why trading was halted, but it still seems like an insider got early access over common shareholders.

Posted by fintime | Report as abusive

“Firstly, they reduce the number of shares outstanding, which means that the value of the remaining shares goes up: the company is worth the same amount, so the value per share is higher.”

A share buyback by definition reduces the value of the company. It uses some of its book value to buy back the outstanding shares. It will not affect the stock price since the loss in book value will be equally offset by the fewer shares on the market. Thus its market cap will be reduced but the per share price will be equal.

Posted by Anonymous | Report as abusive

Felix, you’re completely missing the point. It’s fairly obvious that you haven’t bothered to look into the financials of the company lately (if ever) to get any idea of its value. Berkshire’s intrinsic value is higher than its book value, and if Buffett can buy shares of the company below its true worth, then it is beneficial to continuing shareholders.

Additionally, BRK’s logic towards repurchases is public and well-documented, which (again) you would know had you actually read past company filings.

The fact that you: 1) used Yahoo! Finance for your “numbers” and 2) didn’t even know about BRK’s earlier buyback really shows your lack of knowledge about the company, so why bother commenting?

Should probably stick to talking about AAPL and Greece; keep churning out five-minute analyses like this and you’ll be the next Ben Stein.

Posted by Cogitator99 | Report as abusive

Salmon, you’re missing the point. It’s fairly obvious that you haven’t bothered to look into the financials of the company lately to get any idea of its value. Berkshire’s intrinsic value is higher than its book value, and if Buffett can buy shares of the company below its true worth, then it is beneficial to continuing shareholders.

The fact that you: 1) used Yahoo! Finance for your “numbers” and 2) didn’t even know about BRK’s earlier buyback really shows your lack of knowledge about the company.

Should probably stick to commenting on AAPL and Greece.

Posted by Cogitator99 | Report as abusive

This is all a sham because BRK doesn’t have to go into the market to buy shares. It already owns a ton of BRK shares via the insurance sub, I forget the name, I think it’s National Indemnity. The insurance sub got the shares via the BNSF transaction (it received BRK shares in exchange for BNSF shares), so all BRK need do is go to the insurance sub, buy and retire the shares, and voila, buyback accomplished. Buffett has done this throughout his career, from the very beginning of owning Berkshire. It’s his secret sauce. This is all laid out, albeit somewhat sub rosa, in The Snowball.

Posted by billyjoerob | Report as abusive

@BernardoCM – you’re not missing anything; it’s all the others who are looking for ghosts and have convinced themselves that they see them, particularly this fellow -

“… it still seems like an insider got early access over common shareholders.”

Early access to what – to sell low before the stock popped? The only guy who might have gotten screwed on this deal was the dead guy whose estate may have sold cheap – he’s past caring about that now though. (If Buffett hadn’t done the buy, odds are the estate would have gotten even less.)

Buffett made $3k a share on the 9k shares yesterday – like he has something to apologize to anyone for?

Posted by MrRFox | Report as abusive